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Predictions 2018 Froth and Frustration BREAKINGVIEWS
2 Predictions 2018
3 Predictions 2018 Froth and Frustration
4 Predictions 2018
Contents
Introduction........................................................................... 6
Peaks and pessimists............................................................ 9
Five possible triggers of the next market shock................................................. 9
Best thing Trump and Xi can do in 2018 is nothing..........................................12
Fed calls time on monetary and regulatory activism.......................................14
Bond vigilantes will grab power from central banks........................................15
Verizon will be one of 2018’s few mega-dealmakers........................................ 17
Apple provides hedge against global tech backlash........................................19
Bitcoin speculators face total wipeout...............................................................21
Passive funds will claim a CEO scalp in 2018................................................... 24
Credit markets will enjoy one last hurrah......................................................... 25
Boards and belligerents.......................................................27
Wall Street’s next challenge: graceful retirement........................................... 27
Activists are at the back door of fortress luxury...............................................28
Mega-miners will find good things in small packages....................................30
Big Oil’s discipline reinforces shale’s swing role............................................... 31
Saudi Aramco’s backup IPO plan runs through China.................................... 33
Regulators will drive next wave of EU bank mergers...................................... 35
Bank compliance-cost explosion will abate in 2018........................................ 38
A deluge of scandals in Japan will drive change............................................. 39
India bids adieu to “promoter” capitalism in 2018...........................................41
A Western money manager will turn Chinese in 2018.....................................42
China will pull private capital into state orbit..................................................44
Sexual misconduct will haunt 2018 annual reports........................................46
Contents 5 Code and consequences...................................................................48 Tech salad will come with a side of SLAW in 2018...........................................48 Amazon to become biggest impact investor ever............................................49 Sun will be setting on Silicon Valley imperialism............................................. 52 India’s e-commerce war to surface on U.S. shores..........................................54 Hong Kong will start atoning for missing Alibaba...........................................55 China will plant a tech leadership flag with 5G............................................... 57 Electric cars will catch up with gas guzzlers....................................................58 Uber for everything will arrive in 2018..............................................................60 Polls and populists............................................................................62 U.S. political doomsday will hurt economic growth........................................62 U.S. will miss out on infrastructure again in 2018........................................... 63 Latam’s turn from populism will be put to the test.........................................65 Canada will be biggest loser in U.S. trade spats.............................................66 Germany will follow money in EU top jobs carve-up.......................................68 Britain heads for Brexit in name only................................................................69 Italy will go back to its old ways in 2018............................................................ 71 Sports and substances.........................................................73 European soccer’s spending splurge will intensify.......................................... 73 Musical debuts will produce financial syncopation......................................... 75 As Macau welcomes the humble gambler, bet on MGM................................. 76 China’s shared bikes will merge into car lane.................................................. 78 Temperance is the new craft beer for drinks groups........................................ 79 About Us............................................................................................................. 83
6 Predictions 2018
Introduction
Breakingviews predicts a frothy, frustrated year
There is plenty of discord and uncertainty as U.S. President Donald Trump’s second year
starts. Yet money is cheap, the global economy is motoring, and markets are ebullient.
That combustible mixture could be called “froth and frustration.” How this ironic social
contrast, worthy of Jane Austen, resolves itself will be key for 2018.
Ten years after Lehman Brothers imploded, the bulls are ascendant. A single Hong
Kong skyscraper recently fetched $5.2 billion and an imperfect Leonardo da Vinci sold
for $450 million. With huge run-ups at tech giants such as Apple and Tencent, global
stocks added roughly $13 trillion in value in the first 11 months of 2017. Bitcoin prices
shot for the heavens. Yield-chasers gorged on debut bonds from Tajikistan and the
Maldives, and 100-year debt from serial defaulter Argentina.
This is not all hot air. A world recovery is gathering steam: the World Bank reckons
global growth will hit 2.9 percent in 2018. The last time expansion was faster, China
was splurging on bridges, roads and airports, effectively underwriting a rebound from
the financial crisis. Meanwhile, central banks have barely begun to lift interest rates or
sell assets. And online behemoths such as Alibaba and Alphabet keep growing and
churning out fat profits.
Investors appear to be taking the same mercenary view as one of Austen’s characters: “A
large income is the best recipe for happiness.” Yet things look less reassuring close up.
The populist anger that enabled Trump and Brexit is still simmering, fuelled by
inequality, disruption, immigration and the echo chambers of social media. An
unpredictable America is no longer committed to advancing a rules-based, liberal world
order. China is growing increasingly assertive under President Xi Jinping, while Saudi
Crown Prince Mohammed bin Salman is flexing his muscles around the Gulf. The risk
of a conflagration on the Korean peninsula is all too real. Business is grappling with
self-inflicted scandals and activist attacks, and a backlash is building against Big Tech’s
overweening power.
That is the backdrop for Predictions 2018. We have collected more than 40 in a
single volume, with dozens more available at breakingviews.com/2018. It is a truth
universally acknowledged – to draw from Austen again – that forecasting is hard work.
But it’s nonetheless a useful exercise, at the very least giving readers a way to frame the
big debates ahead intellectually, and perhaps profitably.
Introduction 7 Zombies and vigilantes This year, we are positive on global growth – provided Trump and Xi don’t somehow spoil the party. Midterm U.S. elections could have serious investment implications, with radical candidates edging out compromisers, as could a populist resurgence in Latin America. The bull market need not end badly, although bitcoin could prove a total wipeout – and several other possible triggers for trouble, like blow-ups in exchange-traded funds or hedge funds, bear watching. Perhaps the biggest financial shift will be at central banks. Markets must adjust to increasingly tight policy at the U.S. Federal Reserve under new Chair Jerome Powell. And for the first time in years, rich-world bond issuance will outstrip buying by the Fed and friends. Much like the modern additions to the Austen canon in “Pride and Prejudice and Zombies,” bond vigilantes will rise from the dead. Actors dressed as zombies arrive at the European premiere of “Pride and Prejudice and Zombies” in Leicester Square, London, Britain, Feb. 1, 2016. REUTERS/Stefan Wermut
8 Predictions 2018
The executive suite will see sustained pressure from many sides. Big miners will have to
ape buyout shops. One of Wall Street’s titans will bow out. Passive funds will, despite
their name, dethrone a chief executive. Activists could make an ugly scene in luxury.
In India, the long reign of “promoter” tycoons is, mercifully, nearing its twilight. And
corporate America will need to rethink attitudes to diversity and sexual harassment in
the wake of recent revelations. But that should catalyse positive change, just as a spate
of quality-control crises ought to force Japanese bosses to become more competitive.
In tech, investors can consider a tasty new dish: SLAW, for Spotify, Lyft, Airbnb and
WeWork, four prospective candidates for public life. Europe’s electric cars will catch
up with gas guzzlers in cost terms. And super-fast 5G mobile broadband, on show
at the Winter Olympics and the World Cup, will demonstrate China’s hunger for
technological leadership.
Among tech’s giants, Apple’s position as a privacy-sensitive hardware specialist will give
it some shelter from mounting anger at Silicon Valley’s power and lack of accountability.
Amazon could win friends by choosing a deserving location for its second headquarters.
The sun will begin to set on U.S. tech’s feudal approach to corporate governance.
But Chinese startups could push Hong Kong the other way, while it also bends over
backwards to accommodate Saudi Aramco.
Not all of these prognostications will materialise. Last year, among other things, we
anticipated India’s banking bailout, argued Beijing would offer Trump more carrot than
stick, and correctly highlighted the difficulties Uber and Aramco faced in going public.
Our biggest mistake was overestimating the pace of change in Trump’s America,
which meant we braced for a stronger dollar, a flood of repatriated cash and an
infrastructure bonanza.
With those caveats, we hope this will be an enjoyable and thought-provoking read.
Quentin Webb
Asia Financial Editor, Reuters Breakingviews
Jan. 2, 2018
Peaks and pessimists 9
Peaks and pessimists
Five possible triggers of the next market shock
By Richard Beales
What will cause the next market downturn? It takes a catalyst to trigger one, and
other reagents to sustain it. Breakingviews runs through a few more and less obvious
elements to watch.
Fuel for the next crisis?
Fuel for the next crisis?
Thousand U.S. $ per bitcoin Central bank assets as % of GDP
18 100
16
14 80 BoJ
ECB
12 BoE
60 U.S. Fed
10
8
40
6
4 20
2
0 0
2017 08 10 12 14 16
Source: Thomson Reuters Datastream, central banks, IMF, BitStamp data to Dec. 11, 2017
Source: Thomson Reuters Datastream, central banks, IMF, BitStamp data to Dec. 11, 2017
Central bank surprises
Central bankers like Janet Yellen at the Federal Reserve and Mark Carney at the Bank of
England try not to surprise investors. That’s likely to be a tougher act to pull off in 2018.
Yellen, for one, will soon be replaced by President Donald Trump’s nominee as Fed chair,
Jerome Powell. In addition to being an untested hand, he along with his counterparts
may end up changing policy faster than markets expect. Carney, for example, has
to keep an eye on UK consumer prices, with inflation running at 3.1 percent in the 12
months to November. Any sign that prices are suddenly on the rise could explode
10 Predictions 2018 expectations of very gradual increases in interest rates. Sharp market moves could be amplified by the Fed’s pre-programmed shrinking of its gargantuan $4.5 trillion balance sheet. After a decade of ultra-low rates, there could be huge amounts of exposure to rising interest rates, and in unexpected places. Exchange-traded funds The rapid growth and evolution of easy-to-use ETFs is a boon for investors. The vehicles hold some $4.4 trillion in global assets, according to a recent EY survey, a more than 10-fold increase since 2005. The consultancy predicts 15 percent annual growth in the coming years. That’s all well and good, but a few risks are creeping in. One is the widening range of what ETFs are trying to track. Bond funds, for example, are burgeoning. And increasingly providers are offering proxies for everything from certain hedge fund-like strategies – so-called smart beta – to the equivalent of leveraged bets against stock performance, like triple-short S&P 500 Index ETFs. Some of these risk recreating a problem that bedeviled many banks and investment funds in the crisis of 2008-09: a liquidity mismatch between an ETF that can be traded during market hours and underlying assets that are, or become, illiquid, whether scarce bonds or volatile futures. Just as the failure of long-held beliefs about money-market funds exacerbated the crunch a decade ago, a loss of confidence in key characteristics of ETFs could worsen any future meltdown. Crisis alpha Big pension funds and other institutions have been delighted by buoyant equity markets. The FTSE All-World index, for example, was up 20 percent through Dec. 14, and the U.S. S&P 500 had gained 18 percent. But investors are also worried about the next downturn. One fashionable notion is to put some cash into strategies variously dubbed crisis alpha, crisis risk offset (shortened to CRO) and similar clever monikers. These are supposed to perform positively in any big downturn. One strand of many such models is a strategy known as managed futures, which essentially follow momentum in a raft of liquid markets. These funds delivered big positive returns during the global financial crisis. The danger, though, is that managed futures, and even more so other approaches with less history, could turn out like modern-day versions of portfolio insurance, which was supposed to minimize investors’ losses but ended up amplifying the market crash of October 1987. David Harding at Winton Capital cautions that the success of his own managed-futures sector in recent downturns is not guaranteed to repeat in the next,
Peaks and pessimists 11 and that superficially countercyclical strategies could end up going wrong, especially if too many investors have the same ideas. Hedge-fund trouble To give these funds their due, they weren’t the main fuel for the conflagration of 2008- 09 – that dubious honor goes to banks. Yet leverage and potentially crowded trades can create systemic risks, as Long-Term Capital Management demonstrated in 1998. The largest hedge fund, Bridgewater Associates with $160 billion under management, has as its flagship a so-called risk-parity strategy. It’s designed to spread risk more or less equally across a range of asset types and possible market behaviors, using an element of leverage to help. The fund’s record and reputation are good, but it hasn’t been tested by a sustained bear market in bonds and it’s not immune to a set of circumstances that crater almost all its holdings at once, spreading fear among its legions of clients. Alternatively, large numbers of smaller funds – whose collective assets have doubled since the crisis to top $3 trillion, according to Hedge Fund Research – could end up being caught out by the same market moves, as computer-driven quant funds were in August 2007. Too many investors running for the exit at once is a recipe for market freefall. Crypto-currencies It’s hard for a long-term investor to take seriously a holding that plunges nearly 20 percent in a day and then surges 80 percent to a record high just a week later. That’s what happened to bitcoin between late November and early December, though. For all the talk of its use as a currency along with the related blockchain technology, digital coinage is more than ever the domain of tech-savvy speculators. No wonder, with the value of bitcoin up around 17-fold in 2017 through Dec. 14. The total value of outstanding bitcoin and rival ether reached over $350 billion, according to Coindesk. Much of that is on (virtual) paper, but it’s still symptomatic of booming financial markets combined with the growth of the digital economy. If hacks that exploit technological flaws or a sharp fall in demand crash the price, the fallout could prove contagious to the real world, too.
12 Predictions 2018 Best thing Trump and Xi can do in 2018 is nothing By John Foley The world is headed for a year of smooth economic sailing. How smooth depends on U.S. President Donald Trump and Chinese leader Xi Jinping. The best thing that a duo who steer one-third of the planet’s GDP can do for growth is nothing. Almost half of the 2.9 percent increase in global GDP forecast by the World Bank for 2018 comes from the United States and China. Investment and consumption are rising reasonably strongly in both, and central bank policy will remain generous. The United Kingdom, which is heading for a divorce from the European Union, has a more brittle economy but contributes just 2 percent of the world’s growth. The damage it can inflict will be limited. Trump could cause harm by dismantling the global trading system of which the United States is a linchpin. The U.S. congressional system contains checks and balances when it comes to war or bad policy but the president has considerable freedom on trade. He has already raised tariffs on some Chinese aluminum products. Talks over NAFTA, or the North American Free Trade Agreement, the U.S. trade pact with Mexico and Canada, are tense. Only Congress can annul NAFTA. But if Trump pulls the plug, it will be as good as dead, to the detriment of jobs and productivity. China could crater too, if Xi wills it. Activity will slow sharply if he curbs abundant credit growth, which is boosting house prices, investment, and imports. China’s home-made measure of broad credit, called “total social financing”, is still growing far faster than nominal GDP. True, debt – forecast by the International Monetary Fund to reach 300 percent of GDP by 2022 – is the biggest risk for China and at some point the piper must be paid. But a bigger threat in the near term is a clumsy, too-rapid deleveraging. Xi is less liable to use his powers rashly than the U.S. president. Moderates, such as economic adviser Gary Cohn, have so far tempered Trump’s actions. They may not stick around. Were midterm elections in 2018 to hand the Republican-controlled Congress to the Democrats, support may grow for retaliation against perceived trade slights. Both leaders have good cause to want the synchronized expansion to continue. Besides being responsible for economic smooth sailing, Xi and Trump are also the biggest beneficiaries. Inaction, or impotence, are therefore the best things they can give to the world.
Peaks and pessimists 13
U.S. President Donald Trump and China’s President Xi Jinping make joint statements at the Great Hall of the People in
Beijing, China, Nov. 9, 2017. REUTERS/Jonathan Ernst
Who’s driving
Who's drivingglobal growth
global in 2018
growth in 2018
Here’s how
Here’s howforecast
GDP expansion breaks
global GDP down for
expansion the coming
breaks down foryear, based on
the coming World
year,
based on World Bank estimates.
Bank estimates.
2018 GDP GROWTH SHARE OF WORLD SHARE OF WORLD
FORECASTS ECONOMY IN 2018 GROWTH IN 2018
United States 2.2% 21.5% 16.4%
Euro area 1.5 16.8 8.8
China 6.3 13.2 27.7
Japan 1.0 7.6 2.7
India 7.5 3.5 8.6
United Kingdom 1.5 3.4 1.8
World 2.9
Source: WorldBank
Source: World Bank Global
Global Economic
Economic Prospects,
Prospects, June Datastream
June 2017; 2017; Datastream calculations
calculations14 Predictions 2018 Fed calls time on monetary and regulatory activism By Gina Chon The U.S. Federal Reserve is looking to put its tools away. After almost a decade of near-zero interest rates, massive asset purchases and tighter rules, the central bank is stepping back. Fed chief Janet Yellen started this transition as after-effects of the 2008- 09 financial crisis faded, but her successor, Jerome Powell, promises a real laissez-faire shift in approach. Powell will bring a background in law and a stint at the Carlyle Group to the central bank, which has been led for more than a decade by economists steeped in monetary and labor policy. He has voted with Yellen for the past five years, but his pedigree as an establishment Republican makes him less inclined to believe the Fed should try to address every economic problem. He also echoed President Donald Trump, who appointed him, when he told Reuters Breakingviews in October that his biggest worry was slow economic growth. To promote expansion, Powell has already made moves to relax crisis-era regulations, which will accelerate under his new vice chair, Randal Quarles. The Fed is looking to Federal Reserve Chair Janet Yellen testifies on the U.S. economic outlook before the Congressional Joint Economic Committee on Capitol Hill in Washington, D.C., United States, Nov. 29, 2017. REUTERS/Carlos Barria
Peaks and pessimists 15 ease major constraints on banks, including the annual stress tests, the living wills exercise and the Volcker Rule limiting proprietary trading. Yellen has orchestrated five hikes since December 2015. The Fed projects three more increases in 2018, but with unemployment at a 17-year low of 4.1 percent, Powell may have to step up the pace. Such tightening will coincide with a shrinking of the central bank’s $4.5 trillion balance sheet, which began in October. The Fed bought bonds in an effort to keep rates low and stimulate the economy. The purchases skewed markets just as Yellen and her predecessor, Ben Bernanke, intended. Fed economists estimated that yields on 10-year Treasuries would be about 85 basis points higher if the Fed hadn’t done quantitative easing. By the end of 2018, the balance sheet reduction will be roughly equivalent to a 1 percentage point hike in the fed funds rate, according to research by Benn Steil at the Council on Foreign Relations. It all adds up to a substantial tightening. The central bank will also face pressure to remove accommodation if Congress passes tax cuts, providing fresh stimulus and stoking the deficit. Markets may struggle to adapt to life without a Powell put. Bond vigilantes will grab power from central banks By Swaha Pattanaik Bond vigilantes are poised to wrest back power in 2018. For the first time in four years, the U.S., Japanese, euro-zone and UK governments will together issue more net debt than their central banks will buy. That gives investors a welcome chance to hold profligates to account. But markets may be prone to over-reaction as money managers rediscover their rusty powers of discernment. Combined net debt issuance by these so-called G4 economies will total $1.3 trillion, up by a third from the projected issuance for 2017, according to Morgan Stanley. The increase in supply will coincide with a decline in demand from central banks, which are expected to reduce their combined bond purchases. That makes for a watershed year in which net issuance will exceed official purchases of debt. Bond prices will respond. In the past couple of years, buying by central bankers dwarfed issuance, on a net basis, and drove down yields, sometimes into negative territory. About 43 percent of outstanding European government bonds and 60 percent of Japanese ones were yielding less than zero at the end of October, according to Tradeweb.
16 Predictions 2018
Decline
Declineinin
bond volatility
bond volatility
Merrill
Merrill Lynch
Lynch Option
Option Volatility
Volatility Estimate
Estimate (MOVE)
(MOVE) three-month
three-month indexindex
250
200
150
100
50 50.0
0
03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Source: Thomson Reuters Datastream, data to 12/8/2017
Source: Thomson Reuters Datastream, data to 12/8/2017
Watershed
Watershed year
year for for G4 bond
G4 bond markets
markets
Net government
Net governmentdebt
debtissuances
issuance minus
minus central bank purchases
central bank purchases($
($bln)
bln)
2000
G4 total
1500
1000
U.S.
500
UK
0
Euro Zone
Japan
-500
2010 2011 2012 2013 2014 2015 2016 2017 2018
Local
Localcurrency
y data
currency dataconverted at at
converted year-end exchange
year-end rates
exchange except
rates 20172017
except & 2018 estimates
& 2018 (as of(as
estimates 28/11/17).
of 28/11/17).
Source:
Source:Morgan
MorganStanley
Stanley
Source: Thomson Reuters DatastreamPeaks and pessimists 17 Investors who wanted better returns have been forced to buy longer-dated or riskier debt and venture into other markets. Liquid assets, such as equities, were bid up by what Citi analysts dubbed bond “refugees”. So were illiquid alternatives such as infrastructure and private equity funds. As the balance between the supply and official purchases of government debt flips, investors may return to their natural comfort zone. If all goes well, that shift will be gradual and bond yields will rebound slowly. That’s not a given. Say corporate defaults were to rise markedly. Authorities have dampened market sensitivity to these risks for so long that investors may over-react when confronted with them. Price swings will be further amplified if asset managers find themselves stuck in illiquid markets during a broader selloff. Those who cannot bail out of their riskiest holdings may be forced to sell less risky but more liquid bonds. Bond prices have been getting less volatile for several years. When valuations are less driven by central banks, that will no longer be the case. A necessary shift, to be sure, but one likely to create some unsettling market moves. Verizon will be one of 2018’s few mega-dealmakers By Jeffrey Goldfarb Dealmakers are no longer living large. In 2015, there were more than 60 mergers and acquisitions announced globally worth at least $10 billion. Combined, they accounted for over a third of total M&A volume, according to Thomson Reuters data. By 2017, the trend had reversed. Expect an even shorter list of mega-mergers in 2018, but look for U.S. telecoms titan Verizon’s name to be on it. By the time CVS Health unveiled its $77 billion plan to buy Aetna in December, the number of 11-digit takeovers in 2017 had halved from the record set two years ago. Their total value also had shrunk from nearly $1.5 trillion to about $700 billion. That’s despite the steady increase in market capitalizations and available cash that combine to make such transactions theoretically possible. High valuations, erratic signals on U.S. tax and trade policy, and stronger pushback from trustbusters all conspired to restrain chief executives’ more animalistic spirits. Greater clarity on corporate tax rates could start to change some thinking, but with the S&P 500 index in early December trading at over 18 times earnings, more than 25 percent above its 10-year average, according to Datastream, it could still be hard to pull the trigger on a sizeable acquisition. Verizon is one company that may not have the luxury of time, however. Growth has
18 Predictions 2018
A mobile cell tower is parked outside a Verizon store in Superior, Colorado, United States, July 27, 2017. REUTERS/Rick Wilking
Mega
Megadeals
deals
Mergers
Mergers and
and acquisitions
acquisitionsover
over$10
$10billion
billionininvalue
value
80
Number of withdrawn deals
Number of announced deals % of total M&A value
70
60
50
40
5
30 31
22
20
10
0
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
Source: Thomson Reuters data to Dec. 5, 2017
Source: Thomson Reuters data to Dec. 5, 2017
Source: Thomson Reuters DatastreamPeaks and pessimists 19 been tough to come by and consumers are shaking the ground more strongly under the media and telecom industries. Acquisitions of internet has-beens AOL and Yahoo hardly qualify as game-changers for a $210 billion company. It sniffed around Twenty-First Century Fox, but regulatory resistance to combining wireless and programming power seems to be rising. Regulators sued in November to block AT&T’s acquisition of Time Warner, the owner of CNN and HBO. Instead, Verizon boss Lowell McAdam might be wiser to stick closer to home and consider buying satellite operator Dish Network. It would come with a $45 billion price tag, after factoring in net debt and a 30 percent premium. Even though McAdam has rejected such a combination before, it would help resolve a serious spectrum shortfall at Verizon identified by New Street analysts. Financially, it could be a stretch. For one thing, the Dish enterprise trades at twice the multiple of expected EBITDA for the next 12 months as Verizon. And even if it could wring out the equivalent of 9 percent of the target’s operating costs, as AT&T said it would at Dish rival DirecTV, Verizon’s implied return on investment would be just 4 percent, according to Breakingviews calculations. Nevertheless, McAdam could buck the M&A trend because the rapid upheaval in his industry is such a big deal. Apple provides hedge against global tech backlash By Robert Cyran Authorities worldwide are growing worried about how Facebook, Google and Amazon are eroding privacy, using data to push rivals out of business and even affecting elections. This is one tech battle Apple can sit out. As a security-minded purveyor of hardware, it’s likely to avoid the worst of the blowback. Europe will be the eye of the tech storm in 2018. The European Commission has already fined Google $2.8 billion for favoring its own services and burying rivals in search results. Regulators are now deciding whether the Alphabet unit’s Android mobile operating system gives it another means of unfairly promoting its businesses. A bigger fine and reduced mobile revenue from Google search could result. Fining Google for favoring its own products sets an unwelcome precedent for other tech firms. European Union authorities could proscribe Amazon’s listing of own-label products ahead of competitors’ offerings. The biggest danger comes in May, when companies must comply with Europe’s General Data Protection Regulation. It requires that they seek explicit consent before using
20 Predictions 2018 A customer is shown a new iPhone X at an Apple Store in Beijing, China, Nov. 3, 2017. REUTERS/Damir Sagolj personal data. It’s probable many customers won’t agree, which means Google could find it harder to customize Gmail ads and Facebook might not be able to use WhatsApp information to sell ads on other sites and apps. Customers also have the right to delete their data or port it elsewhere – reducing the ability of Amazon and Google to lock in cloud customers. Parts of Europe’s agenda may be adopted elsewhere. And U.S. lawmakers are mulling putting big internet firms under the strict Federal Communications Commission, rather than the more lax Federal Trade Commission. Apple is the biggest tech giant, worth nearly $900 billion, yet it stands curiously apart. The company sells lots of expensive phones, but it’s no monopolist. The iPhone’s combined share of the five biggest European markets is under 20 percent, says Kantar Worldpanel. Tim Cook’s company also uses privacy as a selling point. It doesn’t gather personal information to sell to advertisers, places similar restrictions on app developers, and fights government attempts to unlock suspects’ phones. Apple’s inability to master social media means its business doesn’t affect elections either. Apple isn’t carefree. The company’s attempts to slither out of paying taxes make it a target in its own right. At worst, though, the result is probably a fine. Its rivals are looking at major, forced changes in their business models.
Peaks and pessimists 21 Bitcoin speculators face total wipeout By Edward Chancellor Bubbles aren’t just about the madness of crowds – nor are they simply manifestations of excess liquidity and leverage. But both of these factors are present in the extraordinary rise of bitcoin over recent months. Every spectacular bubble involves a premonition of the future. The trouble is that they turn out to be deeply flawed premonitions. In this respect, bitcoin has much in common with great historic speculative manias. The acting head of New Zealand’s central bank, Grant Spencer, is correct to say that bitcoin resembles a “classic” bubble. First, there’s the telltale super-exponential price explosion. The South Sea Company stock soared 10-fold in 1720. Today’s red-hot crypto- currency is up more than twice that amount over the last 12 months. Bubble assets also exhibit tremendous volatility during their so-called “blow-off” stage. Bitcoin’s recent price oscillations suggest as much. Great bubbles attract speculators from far and wide. At the high point of France’s Mississippi Bubble, also of 1720, up to half a million foreigners are said to have flocked to Paris. In the internet age, bitcoin leaves John Law’s scheme far behind. Coinbase, which provides bitcoin wallets, now boasts some 12 million accounts – a threefold increase in a year. While the Mississippi fraud minted the first paper “millionaires”, bitcoin appears to be producing digital billionaires – including the Winklevoss twins of Facebook notoriety, according to media reports. Every great bubble produces great anecdotes. Charles Mackay’s account of the early bubbles in “Extraordinary Popular Delusions and the Madness of Crowds” is stuffed with such urban myths. CNBC recently reported that a young Dutch family had sold its house, cars and other possessions, and moved to a campsite. The father intended to feed his children with the profits from trading crypto-currencies. The computer programmer who used bitcoins to buy pizzas back in May 2010 shelled out more than $150 million at current prices for his lunch. George Soros argues that a “superbubble” only forms after it has survived a severe test, imbuing speculators with a sense of invincibility. Bitcoin has weathered a number of such trials. After peaking at close to $1,000 in late 2013, it shed more than 75 percent of its value over the following 18 months, before starting its more recent, epic ascent. Bitcoin has also survived a number of outright scandals, including grand larceny at the Mt. Gox exchange when billions of dollars worth of bitcoins (at current value, anyway) vanished into the ether. All great bubbles occur during periods of easy money, when interest rates are low or falling and liquidity is super-abundant. The Dutch tulip mania, for instance, appeared
22 Predictions 2018 in the mid-1630s at a time of massive capital inflows, falling interest rates and massive money printing by Amsterdam’s Wisselbank, Europe’s first central bank. Sound familiar? At the beginning of 2017, the world’s largest central banks were expanding their balance sheets like never before. Some $11 trillion worth of bonds worldwide currently offer negative yields. The American stock market is more expensive than at any time save for the dot-com peak in early 2000. This leaves savers with an uncomfortable dilemma: speculate or starve. The supreme object of speculation is one which generates no yield and is therefore impossible to value. Think of those tulip bulbs, or gold in late 1970s, or contemporary art in recent years. Bitcoin, which produces no income, has a restricted new supply, and whose ownership is concentrated in relatively few hands (some 95 percent of outstanding coins are held in just 4 percent of accounts), providing a very small free float, is the most perfect speculative asset ever devised. Throw in some leverage, open a futures market, and there’s no limit to bitcoin’s potential upside. The word speculator derives from the Latin word for a “lookout”. The financial variety looks out into the future, and backs this vision with money. Great bubbles are often uncannily accurate premonitions of the future. The 17th-century mania for tulips anticipated the development of the country’s flower industry, now one of Holland’s largest exports. Britain’s railway mania of the 1840s reflected an enthusiasm for the commercial and cultural potential of this new transportation technology. Likewise, speculators in the dot-com bubble foresaw how the internet would profoundly change our lives. Law’s Mississippi Bubble appears most relevant to what is going on today in crypto- currencies. Law believed that money needn’t be backed by any commodity. He established a bank, the Banque Générale, which issued a paper currency and demonetized gold. Law used the newly issued bank notes to support the share price of his Mississippi Company and reduce the rate of interest – in other words, he provided the world’s first quantitative-easing experiment. Law’s vision was prescient. We now live in his world of paper credit and central bank money. However, it was also deeply flawed. Law tried to achieve, in the space of a few years, what would eventually take two and a half centuries to accomplish. Only in 1971 was the link between currencies and gold finally severed with the collapse of the Bretton Woods currency accord. Confidence in what Law called his “system” soon collapsed and the Mississippi Co’s share price fell by 90 percent. Law, who in his heyday boasted of being the world’s richest man, died in penury in Venice. Speculators in tulip bulbs and in all the other great manias have learned the hard way that in investment to be early is to be wrong.
Peaks and pessimists 23 A man walks past a bitcoin mining show booth during a business technology and innovation fair in Riga, Latvia, Nov. 9, 2017. REUTERS/Ints Kalnins This brings us back to crypto-currencies. They aim to cure today’s monetary problems – a lack of confidence in paper credit and central bank money – with a new technology, the “distributed ledger” or blockchain. Bitcoin believers call this revolutionary – it will “change the world”. Perhaps they will be proved correct – in the very long run. But if that time comes, bitcoin won’t be a contender. Its technology is simply too inefficient. Transactions on the network are too expensive, massively energy intensive and can take days to settle. Amazon won’t take payment in bitcoin. The U.S. government won’t accept bitcoin for the payment of taxes. In short, bitcoin as money is going nowhere, except in the markets where it’s been heading vertically upwards. It resembles the gold prospector’s fabled sardine tin: good for trading but not for eating. Super-parabolic price movements often contain their own premonition, namely that the end is nigh for the mania. When the tulip boom ended, the price of Gouda bulbs fell from 60 guilders to what would have been the equivalent of around 10 cents, a price decline of 99.8 percent. Given that bitcoin has soared higher than humble tulips and has even less intrinsic value, a decline of similar magnitude is not out of the question. First published Dec. 13, 2017
24 Predictions 2018 Passive funds will claim a CEO scalp in 2018 By Tom Buerkle and Neil Unmack Index-tracking funds keep gaining market share but companies can’t take their passivity for granted. Firms like State Street, Vanguard and BlackRock are holding management to task on issues like climate change and backing activists. Firing a poor manager is the logical next step. Cost concerns and the failure of most active stock pickers to outperform indexes have turned the flow of funds to tracker products into a tsunami. In the United States, passive mutual and exchange-traded funds that invest in equities attracted $525 billion of new money in the 12 months to October while active counterparts had outflows of $225 billion, according to Morningstar. Moody’s predicts index funds will account for more than half of the U.S. asset-management industry by 2024, nearly double the current share. That growth risks “devouring capitalism,” hedge-fund manager Paul Singer has warned, because index funds have no incentive to push companies to raise performance. Except they do. Outgoing Vanguard boss William McNabb argued in an August letter that the group has to become more active on issues like governance precisely because its funds must hold stocks almost indefinitely. And as the ownership of stocks becomes more concentrated among fewer passive providers, they will have greater clout in shareholder meetings. These investors are backing words with action on issues from gender diversity to pay. State Street voted against directors at 394 U.S. companies in the first half of 2017 because they had no female board members. It joined BlackRock and Vanguard in forcing Exxon Mobil to report on the risks it could face from climate change. Britain’s Legal & General, which manages $377 billion of index funds, voted against 118 pay resolutions in 2016. In September it was part of a shareholder insurrection that nearly ejected the chairman of Sports Direct for weak oversight of the struggling retailer’s founder and chief executive, Mike Ashley. Notwithstanding Singer’s warning, passive funds are helping activists. BlackRock voted against three candidates at aircraft parts maker Arconic, paving the way for Singer’s Elliott Management to take board seats. It also backed Nelson Peltz’s bid for representation at consumer-goods giant Procter & Gamble. There will inevitably be more proxy fights ahead, with passive funds playing a pivotal role. Expect them to cast the decisive vote in sacking a chief executive in 2018.
Peaks and pessimists 25 Larry Fink, chief executive officer of BlackRock, takes part in the Yahoo Finance All Markets Summit in New York, United States, Feb. 8, 2017. REUTERS/Lucas Jackson Credit markets will enjoy one last hurrah By Neil Unmack Riskier borrowers are going to enjoy one last hurrah in 2018. Chief executives and buyout firms will be more adventurous in a year of buoyant global growth. And they will be keen to lock in cheap borrowing costs before central bank policy becomes less generous. But the cheer may not last all year. A pickup in economic activity has yet to translate into a frenzy of risky financing. The value of mergers and acquisitions worldwide fell 4 percent in the year to November, according to Thomson Reuters data. However, deals backed by private equity funds rose 32 percent, and the coming year should be friskier. Several large buyouts are already in the works in Europe, including the sale of Unilever’s spreads business to KKR and a spinoff of Akzo Nobel’s specialty chemicals unit. Private equity firms have good reasons to invest. They have nearly $1 trillion of unspent capital, according to Preqin, and will be happier cooking up bold business plans in 2018,
26 Predictions 2018
Still dancing
Still dancing
Junk bond yields are low... ...and buyouts are piling on debt
Junk bond yields are low... ...and buyouts are piling on debt
30 6.0
BofA Merrill Lynch
Leverage ratios for
Euro High Yield
25 European buyouts*
(bond yield, %) 5.6
5.5
20
15 5.0
10
4.5
5
3.1
0 4.0
06 08 10 12 14 16 06 08 10 12 14 16
Source: Thomson Reuters Datastream, LPC *Debt/EBITDA ratios, 4-quarter average
Source: Thomson Reuters Datastream, LPC *Debt/EBITDA ratios, 4-quarter average
when the global economy will grow by 3.4 percent compared with 3.2 percent the year
before, according to Citigroup.
And bond and loan investors will continue to provide funds cheaply. Policy rates are
low, and the total amount of assets that central banks are purchasing will only be
pared back slowly. The European Central Bank will grow its balance sheet until at
least September. Its policy of buying an average of 7 billion euros of investment-grade
company debt per month forces investors to pile into riskier junk bonds. There’s nothing
to dim the attraction of such debt for now since Fitch Ratings expects the default rate
in the U.S. high-yield bond market to fall to 2 percent in 2018, below the 2.3 percent
average outside of recessions.
But the risks are growing. The average debt-to-EBITDA multiple on senior-ranking
leveraged buyout, loans in 2017 was 4.6 times, in line with the last peak in 2007,
according to LCD, a unit of S&P Global Market Intelligence. And company executives are
growing bolder: take Hochtief’s bid for Abertis, which would push the construction firm’s
debt to over five times its EBITDA.
Faster economic growth could also prompt central banks to raise rates and shrink their
balance sheets more quickly than anticipated. That could make 2018 a year of both
partying and hangovers.Boards and belligerents 27 Boards and belligerents Wall Street’s next challenge: graceful retirement By Antony Currie Retirement beckons for at least one chief executive of a major U.S. investment bank in 2018. Most of those running the top Wall Street firms have been in the job for a long time. And while they might pledge total commitment, each now has a decent excuse to step back: all their companies are on the most solid footing in a decade. JP Morgan CEO Jamie Dimon speaks at a Remain in the EU campaign event in Bournemouth, southern Britain, June 3, 2016. REUTERS/Dylan Martinez Four of the big five institutions – Bank of America, Goldman Sachs, JPMorgan and Morgan Stanley – now have market capitalisations comfortably above book value for the first time since last decade’s financial crisis. Citi’s hovers just below the value of its net assets, but it was whacked hardest by the mortgage bust and its aftermath. Chief Executive Mike Corbat has had, at five years, less time in charge than his peers. Each can claim credit for the recovery. JPMorgan’s Jamie Dimon and Lloyd Blankfein at Goldman Sachs – the two longest-serving chief executives at just over and under 12
28 Predictions 2018 years, respectively, avoided major missteps during the financial crisis. Dimon has grown JPMorgan into a dominant investment and commercial bank. Morgan Stanley’s James Gorman has expanded wealth management and trimmed fixed income, while Bank of America’s Brian Moynihan and Citi’s Corbat have both sold unwanted assets and cut costs. But bank share prices have also benefited from rising rates and U.S. President Donald Trump’s planned tax cuts and rules rollbacks. Between the 2016 U.S. presidential election and Dec. 11, 2017, this triple bonus added more than 40 percent to Goldman’s market capitalisation, more than 50 percent to Citi, JPMorgan and Morgan Stanley and around 70 percent to Bank of America. That must increase the appeal of moving on to executives who have – excepting Corbat – been in charge for longer than the average CEO tenure of eight years, as measured by executive search firm Korn Ferry. Letting go is tough, of course. Blankfein still has to deal with poor performance at Goldman’s fixed-income trading group. Gorman and Moynihan may want to stay until they consistently hit the 10 percent return on equity at which they are creating value for shareholders. That leaves Dimon as the obvious choice to retire first. He has served the longest, and his is the only bank with returns that have beat the S&P 500 since 2010. The coming year is his chance to leave on a high. Activists are at the back door of fortress luxury By Carol Ryan Activists could stir things up in the business of luxury. Family control allows high-end fashion brands to hoard cash and live with second-rate governance. But assertive investors are becoming more willing to take them on, while some companies, like Prada, are more vulnerable than they appear. Investors pushing for change have already targeted jeweller Tiffany & Co and handbag purveyor Kate Spade in the United States. In Europe, Albert Frere’s Groupe Bruxelles Lambert recently became Burberry’s largest shareholder with a 6 percent stake. Burberry is one of the few European players without a dominant shareholder, making activism a more obvious option. Yet Harris Associates has bought 2 percent of the public shares at Richemont, which owns Cartier, and 3.5 percent at Swatch. Both companies are dominated by insider voting blocks. As developments elsewhere show, like Elliott Management’s agitation at Samsung Electronics, entrenched owners shouldn’t be complacent. A Harvard Law School study of 120 shareholder campaigns at companies with a controlling shareholding above 50
Boards and belligerents 29 A woman sits in front of a Burberry shop in Rome, Italy, March 24, 2016. REUTERS/Tony Gentile/File Photo percent found that four in 10 succeeded in getting one or more of the activist’s demands accepted. The luxury sector could benefit from the scrutiny, too. Richemont, for instance, is sitting on almost 6 billion euros of cash. And dealmaking hasn’t always been disciplined. The high price paid by LVMH for Bulgari, for example, means that returns on the investment still aren’t reaching the group’s cost of capital six years later, according to HSBC. Elsewhere, companies that could be leading the way on governance are not: the chairman and chief executive roles remain combined at LVMH, Kering and Hermès. One tool for activists is an Italian law that gives minority shareholders the right to appoint directors. It could give them a way in at companies like Tod’s, Salvatore Ferragamo, Brunello Cucinelli and Moncler. The $8 billion Prada, too, is exposed despite its Hong Kong listing and an 80 percent family holding. And shareholders could easily find things to complain about. For one, the 12.4 million euros paid last year to each of the brand’s co-CEOs, Miuccia Prada and her husband Patrizio Bertelli, amounted to 9 percent of net income. Activists have fewer options at, for example, French giants LVMH and Kering, where outsized voting rights can shut out insurgents. Still, all luxury brands are touchy about their reputations. A high-profile activist assault could lead even powerful families to see the light.
30 Predictions 2018
Mega-miners will find good things in small packages
By Clara Ferreira Marques
Being a global miner is no longer all about size. The industry still depends on moving
tons cheaply. But big producers must increasingly think like small ones. For companies
like Rio Tinto and BHP Billiton, that requires a change of mindset – and in some
cases, leadership.
Commodity producers have for years chased bigger mines, larger diggers and longer
ships. Valemax vessels, giant iron ore carriers, were so large they were unable to dock
in China for more than three years after they launched. BHP’s attempt to buy Anglo-
Australian rival Rio in 2008 epitomised the quest for scale.
When the commodities cycle turned downwards, empire-building bosses like Vale’s
Roger Agnelli and BHP’s Marius Kloppers made way for cooler heads. Divestments and
writedowns followed. The need to cut debt curbed acquisitive tendencies.
That’s changing. First, miners have less debt and more cash. BHP’s free cash flow is
close to where it was in 2011, before prices plunged. The big four miners – BHP, Rio,
BHP
BHPversus
versusmetals
metalsand
andrivals
rivals
Total shareholderreturn
Total shareholder return(incl.
(incl.reinvested
reinvested dividends)
dividends) since
since Mackenzie
Mackenzie became
became CEO CEO
60
Rio Tinto
Glencore
40 BHP Billiton 41.3
Copper*
Iron ore*
20
15.2
0
-8.6
-10.9
-20
-40
-47.0
-60
-80
2013 2014 2015 2016 2017
Source:
Source:Thomson Reuters
Thomson Datastream,
Reuters data todata
Datastream, 12/8/2017 *price performance
to 12/8/2017 *price performanceBoards and belligerents 31 Anglo American and Glencore, with a combined market value of almost $300 billion – have more than halved their net debt since 2013, to just under $44 billion. Secondly, there’s the impact of green energy. Rechargeable batteries have boosted demand for copper, lithium and cobalt – the price of which has roughly tripled since the start of 2016. Sure, new trends are not going to upend sources of profit like BHP’s Australian mega- mines. But miners now need to think like private-equity investors or tech companies, buying small stakes that provide growth or skills. Rio is considering a bid for a stake in Chile’s SQM, the world’s largest lithium miner, sources told Reuters. That would add expertise and some growth, though SQM’s entire revenue only amounts to 6 percent of what Rio made in 2016. Whether current bosses are up to the task is a different question. BHP’s Andrew Mackenzie, for example, has been willing to sell assets, but it took a shove from activist Elliott before he started to actively tackle underperforming divisions like U.S. shale and Canadian potash. Being nimble is tough. A cyclical shift may need a governance shift to match. Big Oil’s discipline reinforces shale’s swing role By Lauren Silva Laughlin Big Oil is going to be disciplined in 2018. That doesn’t necessarily mean less production, but it does mean going for cheaper, faster projects first. That only helps U.S. shale – and means more frustration for oil-producing countries that would like to see a higher price. ConocoPhillips is one U.S. producer that has explicitly discussed a measured approach to future spending. In November, Chief Executive Ryan Lance told Reuters the company would limit production spending to $5.5 billion per year over the next three years, and it wouldn’t invest in projects that required oil above $50 a barrel to make a profit. It’s a common theme. Exxon Mobil, Occidental Petroleum, Royal Dutch Shell and their peers are all under pressure from shareholders to prove they can make money throughout the cycle. Expensive, longer-term projects will be constrained as a result, while U.S. shale, among the fastest and least costly sources of oil in the world, will fill in the gap. In 2017, U.S. tight oil, as shale is also known, solidified its place as the market’s swing producer even as OPEC, the oil world’s dominant cartel, cut production. The International Energy
32 Predictions 2018 An oil pump is seen operating in the Permian Basin near Midland, Texas, United States May 3, 2017. REUTERS/Ernest Scheyder Agency says that though the number of active U.S. rigs fell in 2017, output will continue to rise in 2018. In the nearer term, OPEC’s decision to extend its curbs on production until the end of 2018 will help keep a floor under prices. But shale’s contributions will keep a lid on them. The U.S. Energy Information Administration sees oil hovering at $53 a barrel, with the International Monetary Fund’s estimate slightly lower. Aiming for profit might keep some disciplined. But analysts expect returns on capital for the most focused tight oil drillers to shoot up as a result of the higher prices wrought by OPEC. And $50 a barrel is plenty high enough for drillers in the Midland Basin in West Texas, who can cover their operating expenses at half that. Unless new discoveries or technologies upend the energy sector, shale’s influence will grow. The IEA says U.S. shale output in the 15 years to 2025 will match the highest sustained period of oil output growth by any single country in the history of the oil markets. By then the United States will be the largest liquefied natural gas exporter and, shortly after, a net exporter of oil. Shale has the power to keep oil prices subdued for a long time yet.
Boards and belligerents 33 Saudi Aramco’s backup IPO plan runs through China By Rob Cox and Pete Sweeney Saudi Arabia’s Mohammed bin Salman is a crown prince in a hurry. Besides detaining members of his family in a corruption sweep and painting a high-tech vision of the kingdom’s future, the young ruler-in-waiting is also planning to sell a chunk of the national oil company, Saudi Aramco, to international investors. For that to proceed in 2018, he’ll need to choose a venue besides Riyadh for the listing early in the year. China looks like the best option. Setting aside questions about Aramco’s value, which the crown prince himself has pegged at an ambitious $2 trillion, there are hurdles to bringing what’s likely to be the world’s largest corporation to more traditional marketplaces. Start with London. Britain is bending over backwards to bring Aramco to the London Stock Exchange. Prime Minister Theresa May and then-LSE chief Xavier Rolet traveled to Riyadh and lobbied Aramco’s chairman for the business in April. Over the summer, the Financial Conduct Authority proposed to twist its rules to create a new listing category for companies controlled by sovereign states. Amid some resistance, the rules had yet to be finalized as of early December. Amin Nasser, president and chief executive officer of Aramco, arrives at the Future Investment Initiative conference in Riyadh, Saudi Arabia, Oct. 24, 2017. REUTERS/Hamad I Mohammed
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